How advisors are paid, and by whom, has long been a matter for controversy. A particularly thorny side of the debate revolves around deferred sales charges (DSC), and whether or not they should be phased out by regulators. Two industry experts offer their perspectives on the subject.

Fund dealers can be compensated either by the investor or the fund manager. In the first case, a common scenario involves a dealer charging a 3% front-end load, which is subtracted from the original investment. In this arrangement, if a client puts up $1,000 for a mutual fund, $30 is taken off the top, and $970 ends up in the fund.

In the case where the fund manager compensates the dealer, the entire $1,000 investment goes straight into the mutual fund, and the fund manager pays the dealer 5% to 6% upfront. The fund manager recoups this upfront payment through the yearly management fees he charges the investor, which are about 2% in the case of an equity fund.

But what if a client decides to dump the fund after one year? This poses a problem for the fund manager because he’s relying on the annual management fees to recoup the upfront payment he made to the dealer. If the client backs out of the fund after a year — and doesn’t find anything he likes in the same family of funds — the management fees get cut off. Absent alternative arrangements, this would leave the fund manager with a loss.

DSC fees are those alternative arrangements. They’re a penalty the investor pays to the fund manager for not staying in the fund family long enough for the manager to recoup the upfront payment. The fees are set on a sliding scale, so the sooner a client backs out, the heavier the penalty. A typical arrangement will involve a DSC schedule that requires investors to stay in the fund family for six years to avoid redemption penalties. Once the investor does his time, he can dump it penalty-free.

One advantage of this arrangement is the investor has $1,000 working for him right out of the gate, which is better than having only $970 invested. But according to Frank Lee*, a consultant to the financial services industry, it’s downhill from there.

Whose interests?

The DSC scenario raises questions about the dealer’s loyalties.

“The dealer has an obligation to put the interests of clients first, but when the dealer is being paid not by the client but by a fund manager, it’s highly questionable whether his loyalties are with the client. There’s definitely a conflict of interest here,” Lee says.

The second problem revolves around a possible conflict of interest stemming from the upfront cash-flow advantages for dealers under the DSC scenario. Even in the best of cases, when a dealer gets a front-end load payment directly from the investor, it won’t be as hefty as the 5% to 6% he’ll get from the fund manager in a DSC arrangement.

Moreover, an investor can negotiate the front load down. Most people don’t end up paying more than 2%, and if you’re really good at driving a hard bargain, Lee says, you can get it down to 0%. By contrast, in the DSC arrangement, the dealer gets his 5% to 6% from the fund manager, and it’s a fixed amount.

Yet the dealer pays a price for the hefty 5% to 6% he gets upfront in the DSC scenario. On top of the upfront payment, the dealer gets an ongoing trailer fee. Under the investor-to-dealer front-end load arrangement the trailer is usually 1% of client assets, while in the DSC arrangement it’s normally 0.5%.

So while the dealer gets penalized down the road, he gets much more upfront — which on balance is a better deal.For this reason, “dealers tend to have an interest in pushing clients into the DSC arrangement, even when this is not advisable from the client’s perspective. It’s another conflict of interest,” Lee says.

It might be argued the DSC structure actually encourages a smart approach to investments, even if it wasn’t devised with this in mind. Investors can be impatient and impulsive, and, in extreme cases, impervious to the idea that growth is a long-term process. They want to either see their money double fast or move on to the flavour-of-the-month investment talking heads are trumpeting on TV. DSCs benevolently coerce the investor into being patient.

This is the dealer’s and fund manager’s argument. But it doesn’t hold water, Lee says. The best thing you can do when you realize you’ve made the wrong decision is lick your wounds and get out. And investors aren’t usually guilty of moving in and out too quickly.

“The danger is they just hang on to a bad investment instead of cutting their losses and moving on.”

Another problem: Many clients simply do not realize they are subject to a penalty if they redeem their units one, two, or three years later.

“They think they’re getting a free lunch, because 100% of their money is going to work upfront. They’re unaware of the DSC, and that’s problematic,” Lee says.

There is an element of buyer beware, but the issue of transparency is a strike against DSCs.

There are two ways to approach regulation of these matters. One is to require full disclosure: If everything is plainly disclosed, people will make choices that serve their best interests. The other approach is to assume people can’t always be expected to determine what’s in their own best interests, at least when it comes to complex matters like investments. It’s certainly no rarity even for highly educated people to lack the time and the financial acumen to plough through the documentation on a fund they’ve been advised to buy. With this model, presumably well-intentioned regulators decide to simply ban a practice they deem ill-advised or open to abuse.

Britain and Australia have taken this second approach with their ban on embedded commissions, which effectively means all remuneration must be paid directly by the investor.

“That avoids the potential conflicts of interest inherent in compensation structures that tend to encourage the dealer to look to the interest of parties other than the client,” Lee says.

Not too long ago, the Ontario Securities Commission flirted with the idea of tackling questionable remuneration structures.

Be cautious of Advisors who abuse Deferred Sales Charges (DSC)Written by Jim Yih • 3 CommentsIn a recently read an article on Advisor.ca on the problems of the Deferred Sales Charges (DSC). There may have been a time and a place early in the birth of the mutual fund industry where DSC structures made some sense but in today’s world, everyone would be much better off without the old back end load. If you are not sure what a DSC or back end load is, read this article on mutual fund fees.

A tale of bad, selfish advice

A young couple, Janet and Reg, recently asked me for a second opinion on some advice from their financial advisor. We’ll call him Mr. Advisor.

Janet and Reg started working with Mr. Advisor 6 years ago. Since the beginning of this relationship, he has moved companies twice and now is embarking on his third move in 6 years. He started with World Financial Group and then moved to another mutual fund dealer and now is moving to an insurance based license.

Janet and Reg have 3 investment accounts:

A RRSP with Franklin Templeton worth $25,000A non-RRSP leverage portfolio worth $55,000 (originally $50,000) invested in AGF mutual fundsA non-RRSP mutual fund at Franklin Templeton worth $25,000Mr. Advisor wants them to cash everything out of mutual funds an move it into a Guaranteed Minimum Withdrawal Benefit (GMWB) Segregated Fund with Sun Life using their SunWise Funds. There are so many things about this recommendation that bugs me that I feel compelled to write about it so that anyone getting this type of advice runs away from their advisor as fast as possible.

Why should they pay back end loads when he is recommending them to get out?

Firstly, to get out of these funds, the young couple has to pay over $2500 in back end penalties which the advisor has recommended they pay. What is the benefit to Janet and Reg for paying this fee? For Janet and Reg, there is little to no upside. They get investments with higher fees (1.14% MER for Money market up to a whopping 4.13% MER), they get guarantees that are going to be irrelevant to them in the long term and their chances of performing better are not higher but arguably lower. And when they buy the new investment they will be locked into a new 6 year DSC schedule.

So what’s in it for the advisor? Lot’s! How about a $4200 commission cheque for selling the new Sun Life investments. And let’s not forget about the $4000 he already made from the sale of the Templeton and AGF mutual funds. And let’s not forget about the $2000 in trailer fees he already made over the past 6 years. So who’s helping who here?

And there’s more . . .

So when I asked Janet and Reg about why the advisor is changing firms, Mr Advisor told them it was because the fees and costs of the mutual fund industry was too high. Having been a licensed mutual fund advisor in the past, let me translate . . .Mr. Advisor is now recommending segregated funds because he is giving up his mutual funds license because he can’t make enough money to justify the costs of being an advisor who sells mutual funds. That sounds like a really successful advisor!

Everything about this story sucks and my advice to the young couple was very simple – get a new advisor. There are lots of advisors who can afford to deal with mutual funds and don’t sell funds on a DSC or back end load basis. This story is an extreme example of the conflict of interest that occurs in the financial industry – are advisors recommending products because it’s best for the client or because it’s best for their personal interest? The good news, is not all advisors are this extreme in recommending products based primarily on their own selfish reasons. Unfortunately, this story also proves these advisors still exist. Remember, not all advisors are created equal. For that reason, my hope is that all of Mr. Advisor’s existing clients read this article before they sign on the dotted line to help him earn more commissions for really bad selfish recommendations.

My bigger hope is any investors who recognize that this situation (triggering back end loads to trigger new upfront commissions without re-imbursement) may have happened to them take a stand and let their advisors know this is wrong and not ethical. For new investors, make sure you know what fees are being charged, especially Deferred Sales Charges (DSC) and back end loads.

Are financial advisors profiting during bear markets?Be cautious when you are pitched to borrow to investNot all financial advisors are created equalHow to work with your financial advisors better?Do you know how financial advisors get paid?

John R. Talbott, The Ethical InvestorAuthor, "Survival Investing: How to Prosper Amid Thieving Banks and Corrupt Governments"We have already seen in this series that many investment products on Wall Street like many mutual funds have large annual costs associated with them making them a poor investment choice in the long term. If a mutual fund total costs run 2% per year and the fund generates a 3 percent real return after inflation you are, in effect, giving Wall Street two thirds of the profits that are earned on your investment portfolio. Even ETF's that cost a half a percent to 1 percent per year can end up costing you as much as one third of your total profits over time.

You would think Wall Street would be uncomfortable taking a third to two thirds of your profits. But remember, this is Wall Street. Greed is what they do. There are other more complex products out there that cost investors even more. Not only can the annual costs exceed 2 percent per year, many of these products have enormous sales commissions attached to them of 5 to 12 percent. Brokers push these complex products because of the large sales commissions they earn, but the bank or insurance company also loves it because they aren't paying the commission, you are. And think about it, if the company is paying its salespeople a 5 percent upfront commission, they must be making multiples of that over the life of the product or they wouldn't do it.As a general rule the more complex and complicated a financial product is, the higher its cost to investors and, most likely, the higher sales commissions it earns for your broker.

The entire idea is to create financial products that are so complex that no one completely understands them, it is impossible to analyze them and so it is easy to hide large expenses and fees inside them.

When it comes to complexity of products, the insurance industry has excelled. And, most insurance products, especially those that pretend to be investment products, have very high costs associated with them.

The first rule about insurance is that it is so costly that if you can afford to take the loss don't buy the insurance. You should only buy insurance for events that are so unpredictable and destabilizing to your family that they really could not get by without it.

I bought an alarm clock at RadioShack recently and the salesperson asked me if I wanted to buy the three year extended warranty on the alarm clock. The alarm clock costs $15 and the extended warranty was offered for an additional $12 for three years. The extended warranty is really just an insurance contract and because I figured I could survive if my alarm clock failed in the future I figured I could get by without their extended warranty.

Possibly the highest cost product the insurance industry offers is the variable annuity. It pretends to be a combination of an investment product with an insurance guarantee that ends up costing much more than simply buying insurance and investing your money broadly in the stock market. Sales commissions to brokers who convince their clients to buy variable annuities exceed 5 percent. And the annual costs are greater than even a mutual fund as you end up paying two middlemen, both the insurance company and the fund administrator.

But even more traditional insurance products like life insurance are very costly. Insurance companies get away with it because proper pricing depends on understanding annuity tables and probability calculations unavailable to consumers. It is why some of the largest buildings in most American cities are owned by insurance companies. If you have to buy life insurance stay away from whole life policies also known as cash value, universal life or variable life policies. Buy term insurance and only for the shortest time period you absolutely need it.Another general rule, if you are hearing about an investment opportunity through a television infomercial it is probably fairly high cost to you. Somebody's paying for the ad time and for those actors who endorse the product.A great example is reverse mortgages.

Even with 30 years of investment experience, I wouldn't have the first clue as to how to analyze the true costs of a reverse mortgage. They are enormously complex and combine all the worst attributes of mortgage products, insurance and annuities. In addition, many reverse mortgage companies have come under scrutiny recently by regulators who find their sales practices and operations fraudulent and deceptive.

Many of these high cost products exist and investors are attracted to them because they promise a "guaranteed" return. There really is no such thing.First of all, when times get tough, the very institutions that are making such guarantees themselves will face insolvency and will not be around to act on that guarantee.

Second, there is little value in guaranteeing a 4 percent annual yield in dollars if inflation returns to say 10% per year. Yes, you get your 4 percent per year, but you will be losing 6 percent per year in purchasing power.Just remember, if a financial product is too complicated and too complex for you to understand, this is not an accident. It is intentional. And it will cost you.

I recently updated my analysis on the impact of excessive mutual fund fees on Canadian retirement savings. See below my assumptions, sources, and conclusions

(1) Canadian mutual fund investors will likely be sharing more than 50% of their investment return with the financial industry over the next 30 year period, due to the expected low interest rates and low economic growth and the impact of excessive Canadian mutual fund fees after taking investment return compounding into account.

(2) Canadian mutual fund investors that save regularly over the next 30 years would have close to 25% higher retirement savings if Canadian mutual fund suppliers were charging the world average mutual fund fees rather than Canadian mutual fund fees.

(3) The solution is for Canadian governments to permit Canadians to buy foreign sponsored mutual funds, which charge about half of the Canadian sponsored mutual fund fees. This would involve removing the requirement for foreign sponsored mutual funds to become Canadian registered.

Alternatively, the Canadian mutual fund fees should be regulated like utility rates are in this country.

(4) If Canada intends to remove marketing boards and the quota system for dairy and poultry products, then it should surely be opening the marketplace for mutual funds to international competition first. The impact on Canadians of excessive mutual fund fees is to ensure the low income of most seniors, who are not covered by defined benefit pension plans.

The most straightforward and effective way that Wall Street rips off small investors is for them to lie about the products they are selling you. And it happens all the time. Every day, brokers tell clients that they have a great deal for them; don't worry, it's completely safe; it fits your long term objectives and you can't lose.

We have examined three of the biggest lies in the last three articles to this series (see below). Namely, #5- that putting your money in a money market fund is the same as holding cash (even though most of this money is going to insolvent banks in the US and Europe right now), #6- that bonds are safe investments that guarantee a fixed rate of return (but fail to mention that they could lose half their value if inflation returns as I expect it will), and #7- that equities always outperform bonds in the long run (except when they don't).

But, there are many more. Who hasn't heard a broker tell you that commodities are safer than stocks, that options are safe because there is a limit to how much you can lose, that margin debt allows you to use other people's money to leverage the upside with little to no mention of the downside of having your position closed out at the worst time? That they think a potential investment is a wonderful opportunity but fail to mention that their own trading desk is currently dumping the same security. That their research analyst loves the company, but fails to mention that their investment banking group is getting paid millions to advise the same company.

And the more obtuse the product, the greater the ability to prevaricate. One of the advantages of Wall Street creating complex products like CDO's, reverse mortgages and annuities is no one really knows how they work or how to value them freeing up the salespeople to pretty much say whatever they damn well please as it never will be able to be proven false if disputed. And with complex products, you always have to return to the firm who sold them to you if you want out as they pretty much have a monopoly in their trading and thus extract rather generous bid/ask profit margins for themselves.

The Financial Industry Regulatory Authority (FINRA) is the largest independent regulator for all securities firms doing business in the United States. Here is FINRA's own compilation of the arbitrage complaints it received in 2011 by controversy involved.

Misrepresentation, breach of fiduciary duty and breach of contract are just what they sound like, lying. But, lying can take lots of other forms. Certainly omitting important facts is a form of lying, especially when the broker has a fiduciary responsibility to disclose all relevant facts an investor would need to know to make an informed decision. And the most important fact that is often omitted is how big are the fees going to be and what are the hidden expenses involved.

Failure to supervise and unauthorized trading could reflect an internal personnel management problem, but it could also be an intentional effort on behalf of brokerage firms to give a salesperson lots of leeway in deciding what they tell investing clients and then claim that the salesperson was acting solely on his own or had "gone rogue" if they get caught lying.

Unsuitability is an important area of deceit as it is always in the salesperson's interest to push the client into riskier products that carry higher sales commissions for the broker and higher profits for his bank. Why didn't more brokers move their clients into cash as the market began to tank in 2008? Because, they don't make much money if their clients hold their assets in cash. We will discuss in a later article in this series how brokers are motivated to move clients into high margin products like annuities and other hard to analyze insurance-type products regardless of how "suitable" these products are for their investing clients.

Of course, these deceptions occur because we allow them to occur. Individuals sign brokerage agreements when they open their accounts that say that any legal disagreements cannot be taken to court, that you can't sue the brokerage firm, but rather such disagreements must be settled by binding arbitration, and typically by industry-friendly groups like FINRA. You probably don't have any negotiating leverage in changing this standard language in a brokerage contract, but you can vote with your feet and refuse to deal with firms that ask you to sign such an agreement.

And if the fraud becomes large enough, the SEC and the Justice Department can get involved. But, because of the revolving door between these agencies and private practice, many of the lawyers working there have little incentive to get tough on the banks and brokerage outfits. Most lawyers at the SEC and Justice Department will rotate back to private practice after short stints in the public sector and the biggest client of most big name law firms in private practice are financial institutions. It is, I think, the prime reason that no banking executives have gone to jail during this entire banking and financial fiasco.

No, I believe the entire field of financial advice is badly broken and encourages lying. You would like your broker to have your best interests at heart, but in a system where they are rewarded for selling you things you may not need, lying is, if not encouraged, certainly overlooked as an effective method for these banks to add assets under management and to increase their profitability.

What can you do? I am a big believer in people getting more involved in their investing decisions. To retake control of their investments. To focus more on a few real assets that they understand rather than holding hundreds of paper financial securities they know little about.

Certainly, if people are making promises or guarantees to you, it would seem only sensible to get them in writing by asking them to send you a confirming email. I can tell you that brokerage firms tape record many of their employees' telephone conversations with you, that they hold onto all email and letter correspondence from you, and that if there is a dispute it is unlikely that you will ever see any of this evidence unless it hurts your argument and ends up supporting their position.

Finally, and this is incredibly self-serving so be careful, I think it makes sense to hire a fee-only advisor who can help you with your investments. By paying directly for your investment advice you at least have the opportunity to hear what a financial pro thinks you ought to be doing with your assets to achieve your investment objectives rather than doing things that just maximizes the compensation of some banker and the profitability of his or her bank. I am amazed at the number of investors who were burned in the latest crisis but continue to do things the same old way.

20 Ways Wall Street is Ripping Off Small Investors

Providing nominal returns, not real returns.Encouraging too much diversification, if that's possible.Hiding fees and expenses.Turning you into a passive investor.Convincing you that money markets are the same as cash.Telling you that bonds are safer than equities.Explaining that in the long run equities outperform bonds.Simply by lying about their products.Convincing you that their bank is a large, stable, safe operation to deal with.Recommending products that have enormous sales commissions attached to them.Cheating you on bid/ask spreads.Selling you what they don't want.Measuring your success in dollars.Lending your securities to others.Ripping your eyes out if you ever try to close your account.Grabbing any slight positive real return for themselves.Sticking toxic waste to small investors.Pretending they can pick stocks.Acting like they are your best friend and they have your best interests at heart.Knowing next to nothing about the value of holding real assets like gold and real estate.John R. Talbott is a bestselling author and financial consultant to families whose books predicted the housing crash, the banking crisis and the global economic collapse. You can read more about his books, the accuracy of his predictions and his financial consulting activities at http://www.stopthelying.com

Content concerning financial matters, trading or investments is for informational purposes only and should not be relied upon in making financial, trading or investment decisions.

Before speaking about hidden fees and expenses, I'd like to take a moment to discuss the magnitude of the fees that Wall Street admits to and discloses for managing your money. There is no reason to delve into the world of hidden fees when stockbrokers, financial advisors and mutual funds admit in their own documents to charging clients as much as 1% to 2% per year for investing their money.

If a financial advisor were able to garner 12% returns on your portfolio you might conclude that it was reasonable to pay him 1 to 2% a year in fees. But if general inflation was 9% for that year, like it was for many years back in the 70s and 80s, that would mean the real return on your portfolio after accounting for inflation was not 12%, but more like 3%. And let's assume of this 3% you had agreed to pay your financial advisor or mutual fund 1 to 2% in stated fees. This means that you are giving away 33% to 66% of your profits to your financial advisor. Certainly extremely generous, if not completely crazy.

In today's world of very low inflation the same calculus applies. Now, financial advisors are reporting 6% gains for your portfolio, but inflation is close to 3% so you're real gain in purchasing power or wealth is only 3%. Again his 1% to 2% fees represent 1/3 to 2/3 of your total annual profits.

In addition to these egregious stated fees, Wall Street has many methods to hide additional fees and charges from you. Many Wall Street brokerages and online brokerages offer what they say are no fee accounts. But when you look at them in more detail, inside the account they offer investment alternatives like high fee mutual funds. Who do you think is paying those mutual fund charges? I can assure you banks do not own some of the largest buildings in town and brokers do not earn their million dollar plus salaries by offering their clients free services.

Even savvy investors who try to track the expense ratios of various mutual funds in an attempt to control costs might be surprised to learn that there are other real costs, not reported in the expense ratio, that they are absorbing. These trading and transaction costs are very real, but are not captured in the expense ratio. And how big might these trading and transaction costs be? They can make a fund 2 to 3 times more costly than advertised in its expense ratio. One study in 2009 found that average trading costs for thousands of US mutual funds was 1.44% of total assets which was in addition to their stated expense ratios.

Brokerage commissions make up a significant percentage of these hidden transaction costs. The SEC requires that the total amount of brokerage commissions paid by a mutual fund be disclosed and expressed in aggregate dollars but often it is not translated into a percentage cost and is not included in the expense ratio.

A much less understood cost of doing business with a traditional broker is the bid/ask spread. When you go to sell IBM stock on a market-based exchange you are not given one price, but rather two prices, one at which the broker is willing to purchase your IBM shares, or the bid, and the other at which he's willing to sell you additional IBM shares, known as the ask. While competition amongst brokers and dealers keeps these bid/ask spreads fairly narrow and thus your costs down, things are quite different for small investors using traditional brokers to implement their trades.

The key to keeping broker/dealers honest when they quote you a bid/ask spread is that the broker/dealer cannot know in advance whether you are a buyer or a seller of shares. If he knew that you are a seller of IBM, he would push the bid/ask spread that he quoted you against you such that you would recognize significantly less in aggregate for the sale of your IBM shares. This is a cost of dealing with a brokerage that few people truly understand.

And this is exactly what happens in a traditional broker/small investor relationship. When you tell your broker that you want to sell a block of IBM shares, he doesn't call his broker/dealer and ask for an unbiased bid/ask spread. Instead, most likely, he tells his broker/dealer that he has a small investor that wants to sell IBM. His broker/dealer, working for the same company, knows to push the bid/ask spread against you and rob you of additional dollars from your IBM share sale.

While bid/ask spreads can be as narrow as .1% in a perfectly functioning market, when the broker/dealer knows what side of the trade you intend to be on, whether you are a buyer or a seller, he can artificially inflate the bid/ask spread three or four-fold.

And that presumes that you have an ongoing relationship with that broker. God forbid you decide to cut these brokers out of your investments. Once brokers and their broker/dealers realize that you are ending a relationship with their brokerage there is no limit to how greedy they can become and how much they can punish you by quoting enormous bid/ask spreads and quoting very low prices for liquidating your portfolio at their firm. I have seen clients of my investment advisory service lose as much as 5% to 7% of their total portfolio value when they ask to leave a brokerage relationship.

We haven't even mentioned the possibility of soft money transaction costs in which brokers put you into funds that are run by friends who end up compensating the brokerage with either free research or increased trading volume. The broker is getting something for free, but you aren't. You are paying the full fees of the broker's friend's fund out of your portfolio's potential profits.

Finally, there is a cost to aggregating everyone's trading of stocks in a big mutual fund. The big mutual fund, when it wants to get out of its IBM stock has such an enormous position to unload that it can literally move the market price against the firm. By being big, the mutual fund creates its own illiquidity which means to sell a big position they net less dollars. It costs more for the firm to get in and out of its big positions than it would you. These costs can be even bigger than the total brokerage commissions the funds pay so is an additional cost to you the investor.

If all this seems unbelievable to you, it really is much worse that I have presented. For you see, modern finance theory has pretty much proven empirically that these brokers and their firms and their research staffs bring little value to you or your investments. As a matter of fact, mutual funds over the long-term have underperformed the stock market by almost exactly the amount they charge in fees and expenses. There is no real value to any of their stock picking, research ideas or trading.

So if you're saving for retirement and have an investment horizon of some 30 years and have agreed to pay your broker 1 ½% to 2 1/2% in stated and hidden fees and expenses, your wealth may not increase, but his definitely will. As a matter of fact, if he takes 1 1/2% per year from your portfolio and it ends up growing simply at the inflation rate, he will end up with more than half your wealth in 30 years. Now you know why bankers can pay themselves millions of dollars in bonuses.

If you think the answer is to just buy and hold a passive low-cost well diversified index fund, you will have to wait for our next installment of The Ethical Investor in which we argue that Wall Street is turning us into passive sheep ready for shearing and they have the clippers ready.

← Previous Next →Both sides of the same coin if truth be told: fee based and commission based remuneration for advisory accounts…Posted on August 15, 2012IIROC has recently sent out a guidance note, “Compensation structures for retail investment accounts”, for comment.

“This Guidance Note identifies specific considerations that should be taken into account by Dealer Members and Approved Persons when they are designing, recommending or supervising the various compensation arrangements that may be available to retail clients.”

I must admit, I started to get interested when it referred to moves made by international regulators to remove commission based compensation structures and thought there might be some discussion of this issue in this guidance note:

The emergence of significant and wide-reaching advisor compensation-related reforms around the world underscores the need for Canadian regulators, industry and investors to be aware of these international developments and to monitor their impact, if and when implemented.

Unfortunately no: this guidance note does not discuss doing away with commission based services at all, only how to regulate suitability and disclosure of the two payment options for transactions. That is it deals with a) the option to pay commission and commission type fees (i.e. trailer fees) on a transaction by transaction basis or b) the option to pay an annual fee in place of commissions. This is an altogether different thing.

The fee based account is really a bulk transaction discount, priced at a level that makes sure both advisor and institution earn enough from their customers who decide to proceed with this option. While it is suggested that one of its many advantages is that it removes the temptation to churn an account, there is plenty of room to take advantage of the investor: clients who transact little and therefore have a minimal commission trail can be plonked into a fee based account and thereby increase advisor and firm remuneration.

Preventing abuse of the fee based account option is the main thrust of the document, everything else is irrelevant and an inappropriate context. The document deals principally with suitability issues: that is making sure that commission based and fee based accounts take into account the transaction profile of the customer. Those who transact most may be better off in a fee based account, and those who transact little may be better off in a commission based account.

But there are issues here:

The first is that it reinforces transaction based regulation: you cannot charge a fee for a client likely to make one or two trades a year into ETFs, which may be the most suitable option, meaning the client is less likely to receive recommendations that encompass no more than a couple of ETF trades a year.

The second is that the fee is less likely to be set at a level which benefits the client’s interests, because the fee based account settings determine when customers need to be transferred into lower cost options. The bar for fee based accounts therefore risks being set too high.

Of course, if firms were allowed to provide higher level advisory services with fiduciary type responsibility, then fee based services could be set for any transaction levels and greater competition in service fees would likewise be the result.

Also of interest is information on the breakdown of the market place, especially that between managed (discretionary) and advisory (buyer beware, customer responsible for the transaction). Only 9% of the market place (presumably by accounts and not by funds)) is discretionary, 23% is discount online and the balance, some 68%, is advisory.

Order execution – discount online brokerage – 23% of market placeAdvisory accounts – the balance (of which 10.7% are fee based accounts)Managed accounts (discretionary) – 9.1% and growingI do however find it odd that IIROC considers it important to review the suitability of transactions and account payment options, at regular intervals, but it does not consider it necessary to review whether the client is better suited to a discretionary fiduciary type relationship as opposed to the limited “advisor” responsibility of the transaction based advisory service. Finally, it does not even touch on true fee based financial advice:

Given our focus on IIROC Dealer Members and Approved Persons, this Notice does not provide specific substantive guidance on hourly compensation arrangements.

There is a striking similarity between the behavior of many investors and those suffering from "battered person syndrome". Those unfortunate souls involved in abusive relationships often believe the violence was their fault. They can't make the intellectual leap of placing the blame on the abuser where it belongs. They ascribe to the abuser an irrational belief that he (or she) is omnipresent and omniscient.

For years, investors have been separated from their money by a greedy and often corrupt securities industry, culminating in the 2008 meltdown which almost precipitated a global depression and caused a restructuring of the financial services industry.

If they can't manage their own money, why do you entrust them with yours?

Remarkably, nothing has changed. Here are some recent events:

Ratjat. K. Gupta, formerly the head of McKinsey & Company and a former member of the board of Goldman Sachs, was convicted of conspiracy and securities fraud. Mr. Gupta leaked boardroom secrets to Raj Rajaratnam, a billionaire hedge fund manager. In May, 2011, Mr. Rajarathnam was convicted of insider trading and subsequently sentenced to 11 years in prison.According to an article in Rolling Stone by Matt Taibbi, three executives employed at GE Capital (owned by General Electric) were convicted of antitrust violations for colluding to rig bids on municipal bonds. According to Mr. Taibbi, this was a "breathtakingly broad scheme to skim billions of dollars from the coffers of cities and small towns across America. The defendants allegedly colluded with "virtually every major bank and finance company on Wall Street." Mr. Taibbi aptly called it: "The Scam Wall Street Learned from the Mafia."Just the kind of people you want to entrust with your money.

You should make it your habit to parse through the Litigation Releases issued by the SEC almost daily. The theme of most of these cases is remarkably consistent. Investor gives money to broker or advisor who promises high returns with little risk. Broker or advisor pockets the money or uses it for purposes unrelated to the investment. Investor loses all or most of her investment.

Yet, hope springs eternal.

I am overwhelmed with emails from readers who are in the "omnipresent and omniscient" phase of abused investor syndrome. One former client told me she had decided to obtain citizenship in a tiny island, sell all her assets, buy gold and move there. She was absolutely convinced an economic tsunami was fast approaching. Her "guru" sold both access to citizenship and gold. One stop shopping. It wasn't of much comfort when I told her I didn't understand how her new residence would escape the consequences of this disaster. I also noted that hoarding gold on a remote island might expose her to risks she had not contemplated.

Most members of the securities industry are not criminals -- at least not the kind defined in the penal code. They are far more dangerous. They claim to have "expertise" in stock picking, market timing, manager picking or the ability to put you in investments with big returns and modest risk. Most investors believe them.

Sound familiar? If so, you can learn a lot from the literature on battered woman syndrome. Studies show the longer the women stay in the relationship, the more likely they are to be seriously injured.

The lesson for investors is clear. Your "market beating" broker or advisor can't hurt you if you end the relationship.

Dan Solin is a senior vice president of Index Funds Advisors. He is the New York Times bestselling author of The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, The Smartest Retirement Book You'll Ever Read, and The Smartest Portfolio You'll Ever Own. His new book is The Smartest Money Book You'll Ever Read. The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.

Facing a slump after the financial crisis, JPMorgan Chase turned to ordinary investors to make up for the lost profit.

But as the bank became one of the nation’s largest mutual fund managers, some current and former brokers say it emphasized its sales over clients’ needs.

These financial advisers say they were encouraged, at times, to favor JPMorgan’s own products even when competitors had better-performing or cheaper options. With one crucial offering, the bank exaggerated the returns of what it was selling in marketing materials, according to JPMorgan documents reviewed by The New York Times.

The benefit to JPMorgan is clear. The more money investors plow into the bank’s funds, the more fees it collects for managing them. The aggressive sales push has allowed JPMorgan to buck an industry trend. Amid the market volatility, ordinary investors are leaving stock funds in droves.

In contrast, JPMorgan is gathering assets in its stock funds at a rapid rate, despite having only a small group of top-performing mutual funds that are run by portfolio managers. Over the last three years, roughly 42 percent of its funds failed to beat the average performance of funds that make similar investments, according to Morningstar, a fund researcher.

“I was selling JPMorgan funds that often had weak performance records, and I was doing it for no other reason than to enrich the firm,” said Geoffrey Tomes, who left JPMorgan last year and is now an adviser at Urso Investment Management. “I couldn’t call myself objective.”

JPMorgan, with its army of financial advisers and nearly $160 billion in fund assets, is not the only bank to build an advisory business that caters to mom and pop investors. Morgan Stanley and UBS have redoubled their efforts, drawn by steadier returns than those on trading desks.

But JPMorgan has taken a different tack by focusing on selling funds that it creates. It is a controversial practice, and many companies have backed away from offering their own funds because of the perceived conflicts.

Morgan Stanley and Citigroup have largely exited the business. Last year, JPMorgan was the only bank among the 10 largest fund companies, according to the research firm Strategic Insights.

“It said financial adviser on my business card, but that’s not what JPMorgan actually let me be,” said Mathew Goldberg, a former broker who now works at the Manhattan Wealth Management Group. “I had to be a salesman even if what I was selling wasn’t that great.”

JPMorgan has previously run into trouble for pushing its own funds. In a 2011 arbitration case, it was ordered to pay $373 million for favoring its products, despite an agreement to sell alternatives from American Century.

JPMorgan defends its strategy, saying it has “in-house expertise,” and customers want access to proprietary funds. “We always place our clients first in every decision,” said Melissa Shuffield, a bank spokeswoman. She said advisers from other companies accounted for a large percentage of the sales of JPMorgan funds.

At first, JPMorgan’s chief, Jamie Dimon, balked at the idea of pushing the bank’s investments, according to two company executives who spoke on the condition of anonymity because the discussions were not public. Several years ago, Mr. Dimon wanted to allow brokers to sell a range of products and move away from its own funds. Jes Staley, then the head of asset management, argued that the company should emphasize proprietary funds. They compromised, building out the fund group while allowing brokers to sell outside products.

Now, JPMorgan is devoting more resources to the business, even as other parts of the bank are shrinking. Since 2008, JPMorgan has added hundreds of brokers in its branches, bringing its total to roughly 3,100. At the core of JPMorgan’s push are products like the Chase Strategic Portfolio. The investment combines roughly 15 mutual funds, some developed by JPMorgan and some not. It is intended to offer ordinary investors holdings in stocks and bonds, with six main models that vary the level of risk.

The product has been a boon for JPMorgan. Begun four years ago, the Chase Strategic Portfolio has roughly $20 billion in assets, according to internal documents reviewed by The Times.

Off the top, the bank levies an annual fee as high as 1.6 percent of assets in the Chase Strategic Portfolio. An independent financial planner who caters to ordinary investors generally charges 1 percent to manage assets.

The bank also earns a fee on the underlying JPMorgan funds. When Neuberger Berman bundles funds, it typically waives expenses on its own funds.

Given the level of fees, one worry is that JPMorgan may recommend internal funds for profit reasons rather than client needs. “There is a real concern about conflicts of interest,” said Andrew Metrick, a professor at the Yale School of Management.

There is also concern that investors may not have a clear sense of what they are buying. While traditional mutual funds update their returns daily, marketing documents for the Chase Strategic Portfolio highlight theoretical returns. The real performance, provided to The Times by JPMorgan, is much weaker.

Marketing materials for the balanced portfolio show a hypothetical annual return of 15.39 percent after fees for three years through March 31. Those returns beat a JPMorgan-created benchmark, or standard of comparison, by 0.73 percentage point a year.

The actual return was 13.87 percent a year, trailing the hypothetical performance and the benchmark. All four models with three-year records were lower than the hypothetical performance and the benchmarks.

JPMorgan says the models in the Chase Strategic Portfolio, after fees, gained 11 to 19 percent a year on average since 2009. “Objectively this is a competitive return,” said Ms. Shuffield.

The bank said it did not provide actual results for the investment models in the Chase Strategic Portfolio because it was standard practice in the industry to wait until all the parts of the portfolio had a three-year return before citing performance in marketing materials. She said the bank was preparing to put actual returns in the materials.

Regulators tend to discourage the use of hypothetical returns. “Regulators frown on using hypothetical returns because they are typically very sunny,” said Michael S. Caccese, a lawyer for K&L Gates.

While brokers do not receive extra bonuses or commissions on the Chase Strategic Portfolio, some advisers said they had felt pressure to recommend such internal products as part of the intense sales culture. A supervisor in a New Jersey branch recently sent a congratulatory note with the header “KABOOM” to an adviser who had persuaded a client to put $75,000 into the Chase Strategic Portfolio. “Nice to know someone is taking advantage of the best selling day of the week!” he wrote.

JPMorgan also circulates a list of brokers whose clients collectively have with the largest amounts in the Chase Strategic Portfolio. Top advisers have nearly $200 million of assets in the program.

“It was all about the money, not the client,” said Warren Rockmacher, a broker who recently left the company. He said that if he did not persuade a customer to invest in the Chase Strategic Portfolio, a manager would ask him why he had selected something else.

Cheryl Gold said she got the hard sell when she stopped by her local Chase branch in New York last year and an adviser approached her about the Chase Strategic Portfolio.

“They pitched this product to me, and I just laughed,” said Ms. Gold. “I saw it as a way for them to make money at my expense.”

(advocate comment.......here in Canada, according to IFIC, 91% of mutual fund sales in 2007 went into highest fee products like this.......it is standard industry practice in Canada to abuse investment customers for greater fees..........see the flogg topic GET YOUR MONEY BACK)

Subject: Seen on a CIBC release re settlement of a complaint brought before OBSI

Seen on a CIBC Release document re settlement of a complaint brought before OBSI IT IS UNDERSTOOD AND AGREED that the aforesaid considerationis deemed to be no admission of any liability or obligation of any kind whatsoever on the part of the Releasees. This is amazing- OBSI recommends compensatory payment due to CIBC wrongdoing and CIBC denies wrongdoing as part of the release the victim is asked to sign before she can get the money OBSI recommended as compensation!

(advocate comment: Although this article is US based, I feel it is worth reading to better understand a common trick of investment firms north and south of the border. The trick is to never let the customer know the differences between a discretionary account or a non-discretionary account, nor, more importantly telling them the differing legal implications of each, and duties of care. Then, the customer is led into the belief that the "advisor" is working for them, and in their better interests (which is not often the case), while never being made aware of the trick that investment firms will pull on them if the account gets into trouble.The trick, is, if the customer complains, to pull out the "non-discretionary" definition, which will be the very first time the customer will have been informed of this, and they will claim in court that, "the customer was the author of his own misfortune". They base this on the non discretionary account needing approval (head nodding) of each decision by the client.

Thus the industry can pretend to be acting in some kind of professional duty to the client, whilst never having to inform the client of the falsehood of this, or the misrepresentation of this, and when push comes to shove, they beat the client with the hidden trick of a non discretionary account. Fraudulent.

There are two general types of investments accounts: non-discretionary and discretionary. A non-discretionary account requires the broker to obtain authorization before it makes any investment decisions. A discretionary account allows an investment broker to make account transactions without the client’s prior approval. The problem is twofold: (1) brokers often treat non-discretionary accounts as if they were discretionary, and (2) brokers do not adequately explain the difference between the two accounts to the customer.

Suppose you, the average investor, open an account with a brokerage firm. Chances are you will do so without knowing whether the account is discretionary or non-discretionary. Down the road, the broker messes up, defrauds you, and makes grossly unsuitable investments. You want to take legal action, but you are uncertain. What will be the broker’s defense? He will say the account was non-discretionary and deny responsibility. In other words, he will blame you. He will say you were in control of the account, not him. No doubt, this is news to you. After all, the broker acted like he was in control. There was implicit understanding that he was in control. The only basis the broker has for saying that he was not in control is the non-discretionary status of the account.

How do you overcome this defense? How do you prove that the broker was in control, even though the account was non-discretionary? Answer: You have to prove the broker “assumed” or “usurped” control of your account.

A broker is not insulated from a charge of unsuitable trading merely because the customer did not vest the broker with formal written discretionary authority. Rather, where it can be shown that the customer-broker relationship is such that the broker in fact manages the trading in the account, control will be found. (In re Thomas McKinnon Secs., CCH Fed Secur L Rep ¶ 99104 (1996, SDNY)).

While an otherwise intelligent customer will not be allowed to hide behind a mask of ignorance, the customer's sophistication and success in one area of life will not necessarily mean that he or she will be found sophisticated enough to understand all the risks of a particular investment or trading strategy, so as to protect the broker from a finding that the broker controlled an account. Clark v. John Lamula Investors, Inc., 583 F.2d 594 (2nd Cir. 1978); Cruse v. Equitable Sec. of New York, Inc. 678 F.Supp.1023 (SDNY 1987).

Of critical importance are the personal characteristics of the customer, such as his or her age, education, general intelligence, and business and investment experience. Control is likely to be found where the customer is particularly old, young, lacking in education, or was inexperienced in the stock market or lacked financial sophistication. Hecht v. Harris, Upham & Co., 283 F.Supp. 417 (9th Cir. 1980) (finding control when customer was particularly old); Kravitz v Pressman, Frohlich & Frost, Inc., 447 F.Supp.203 (Mass. Dist. Ct. 1978) (finding control when customer was particularly young); Leib v. Merrill Lynch, Pierce, Fenner & Smith, Inc. (E.D. Mich. 1978) (finding control when customer lacks education); Carras v. Burns, 516 F.2d. 251 (4th Cir. 1975) (finding control when customer lacks education or is inexperienced in the stock market or is lacking financial sophistication).

Another factor closely examined by the courts is the relationship between the broker and customer, whether it was an arm's length business relationship or a combination of business and friendship.

Also significant are the reliance placed on the broker by the customer. Fey v. Walston & Co., 493 F.2d 1036 (7th Cir. 1974); Petrites v. J.C. Bradford & Co., 646 F.2d 1033 (Fla. 5th DCA); Marshak v. Blyth Eastman Dillon & Co., 413 F.Supp. 377 (ND Okla 1975). If a broker has acted as an investment adviser, and particularly if the customer has almost invariably followed the broker's advice, the fact finder may consider this as evidence that the relationship is discretionary and that the broker owes a fiduciary duty to the customer. Patsos v. First Albany Corp., 433 Mass. 323, 741 N.E.2d 841 (Mass. 2001).

A course of dealing in which a broker executes trades without client's prior approval suggests that the account is discretionary for purposes of broker's fiduciary duties; similarly, if a broker has acted as an investment adviser and client has frequently relied on that advice, there is a strong indication that the account is discretionary. In re Murphy, 297 B.R. 332, 41 Bankr. Ct. Dec. (CRR) 226 (Bankr. D. Mass. 2003).

Past evidence of following broker's advice will establish control. If a broker has acted as an investment adviser, and particularly if the customer has almost invariably followed the broker's advice, the fact finder may consider this as evidence that the relationship is discretionary and that the broker owes a fiduciary duty to the customer. Patsos v. First Albany Corp., 433 Mass. 323, 741 N.E.2d 841 (Mass. 2001).

As noted by the Second Circuit, a broader duty may be recognized in a non-discretionary account in the following circumstances:

(1) if the broker has engaged in unauthorized transactions or has otherwise effectively taken over the handling of an account even though it is labeled as a self-directed account;

(2) if the client is prevented by "impaired faculties" or extreme lack of sophistication from understanding the basics of trading and thus simply lacks the capacity to handle such an account;

(3) if the broker "has a closer than arm's length relationship" with the client;

(4) if the broker violates legal or industry requirements concerning risk disclosure when opening an account; or

(5) if the broker offers advice on a specific transaction that was "unsound, reckless, ill-formed, or otherwise defective."

HOW TO AVOID GETTING RIPPED OFF BY FINANCIAL 'ADVISORS'5/14/2012 1:13:25 AM

HOME : FEATURES : COLUMNS : How to avoid getting ripped off by financial 'advisors'

ADVISOR’S PERSPECTIVEValuable insight and opinion on financial, investment, and retirement planning from an experienced industry expert.

How to avoid getting ripped off by financial 'advisors'

By Bruce Loeppky | Monday, April 30, 2012

ADVISOR'S PERSPECTIVEWhen financial advisors first get into the business, we basically agree to run our practice by certain common-sense rules and abide by a demanding code of conduct. But some advisors stray from the rules, and the worst ones make the headlines. That gives the entire industry a bad name, which is unfair, because the vast majority of advisors are hard-working, highly ethical individuals who take their responsibilities as seriously as any other professional. It’s not often easy to spot the bad apples, so in this article, I’ll provide some examples of practices that are frowned upon, unethical, or just plain bad business. If you spot any of these, all your alarm bells should go off.

Churning and the DSC option

There are two main methods of churning – that is, buying and selling securities simply to make a commission. Churning mostly occurs in a stock account where a broker is making countless trades simply to generate commissions. It can also occur with mutual funds, where an advisor recommends purchasing a fund with a deferred sales charge (DSC) when a previous DSC fund has either matured (all units are fee-free) or almost matured.

If a DSC fund has almost matured and has $1,000 left in fees, a favorite play of an unscrupulous advisor is to either let the client eat the $1,000 or rebate it back to them, while he earns $4,000 (for example) on the DSC from the new fund(s), leaving him or her with a tidy profit for simply shuffling the deck.

When advisors make fund switches, it is called “servicing,” and your advisor already gets paid for that. Servicing is part of the job. Locking clients in for a second time at a hefty additional fee is not.

Almost every mutual fund pays financial advisors a “trailer fee” for ongoing management. In the old days everything was done with a big commission upfront, but some disreputable advisors made the big sale and neglected to stay in contact with the client, which is not how financial planning is supposed to work. The trailer fee was created to punish an advisor who doesn’t provide service or gives poor advice to a client who can vote with their wallets (go elsewhere), and this will affect the advisor in the pocketbook.

Most financial advisors attempt to see clients once or twice a year to review their portfolios and make any changes necessary due to changes in the client’s life or fundamental changes in the marketplace.

Stocks should be traded only if the broker or advisor can provide justification as to why the client would be better off making the trade and can back up his or her arguments with facts and figures.

A DSC mutual fund that is almost fee-free or is already fee-free should never be moved back to a DSC fund, because the advisor would then be getting paid twice on the same money. That’s not fair to Mr. Client. If you have had this done to you, or have been asked to do this, first call your advisor’s boss and then make a complaint with a regulatory board or securities commission. These are the Mutual Fund Dealers Association (MFDA) for mutual funds, the Investment Industry Regulatory Association of Canada (IIROC) for stocks, or your provincial securities regulator.

My personal belief is that the DSC option should be used very sparingly. Advisors new to the business might use it in the early years to help get their practice off the ground, but only if the fund first meets the client’s needs. But I have heard of veteran advisors who earn over $300,000 per year and still use the DSC pricing option that can lock a client into a fund company for six or seven years. The DSC option takes away clients’ flexibility, so how can that help the client? My advice is this: If your advisor recommends rolling a maturing DSC fund over into another DSC fund, find another advisor.

Always buy no-load funds (that is, zero front-end commission), so you can always redeem or switch with no fees or worries. Your advisor will earn money for managing your account, but won’t receive a big commission on the fund purchase plus fees for managing your account.

There is a low-load fund purchase option that locks you into the fund company for two to four years. Your advisor earns less commission for a low-load fund (usually 2% compared with 5% for DSC fund), but it’s still best to avoid.

Leverage

Be very leery of using leverage (borrowing to invest).This can be used in limited circumstances, but this strategy has hurt many investors who don’t get the complete picture of the risks involved. If your advisor recommends a leveraging strategy to you, listen to see if he or she mentions the severe impact that down markets or corrections will have on a leveraged investment. But if all your advisor shows you is a graph of a steady 7% gain every year for a decade, run away quickly, because markets don’t ever do this, let alone for 10 years.

Leverage is a long-term strategy for those who know precisely what they’re getting into. Consider leverage as a strategy only if you first maximize your RRSPs and TFSA every year, don’t owe too much on your mortgage, and have a job where downsizing the workforce isn’t easy to do (nurses, teachers, firefighters, doctors, police officers, to name a few of the “safer” occupations). You can write off the interest servicing costs of your debt for tax purposes, which is a benefit, I suppose, in the same way you can use capital losses to offset capital gains – but that’s not enough of a compelling reason to use an aggressive strategy like leverage.

Remember that although leverage can build assets quickly, it can destroy assets just as fast. If the value of a leveraged asset drops, you could be in the unfortunate situation of paying off a loan on an asset you no longer want, and that may in fact be worth less than your loan. In addition, you can spend a lot of time in the hole, paying interest on your debt as you wait for the value of your asset to recover. And it’s a lot tougher to climb out of a hole than it is to dig it. A $40 stock that drops to $20 has lost 50% of its value. But just to get back to its original $40 value, that $20 stock will have to gain 100%!

Living by the rules

Most advisors live by the rules – not only because it’s the right thing to do, but also because it’s good for business. We get into the business to help our clients reach their financial goals. We aim to fulfill our obligations with integrity and good faith; to know and understand the financial circumstances of our clients and to serve them by meeting their needs; to make suggestions for change in a personal financial program only in the client’s best interests; and so on. I know of no other way to gain and keep clients through the years.

So if you ever think a strategy is unsound or too risky, don’t be afraid to check it out with a reputable and knowledgeable source for a second opinion. After all, it’s your money, and your financial future.

Bruce Loeppky is a financial advisor based in Surrey, B.C., and a regular contributor to the Fund Library. He can be reached at sloeppky-1@shaw.ca.

Any one of these tricks has the potential to cut your retirement in half, over the long term, while placing the other half into the hands of the trusted financial industry.

Two former clients of mine paid me a visit recently, showing me their mother's account and asking me for my thoughts about how it was managed. Here is what I said to myself as I flipped through the pages:

ONE, The misrepresentation of commission salespersons as “advisors”, which is a LICENSE VIOLATION since “advisor” is a legal license category at each securities Commission. (see “salesperson or advisor” topic at http://www.investoradvocates.ca )

456 records at the Alberta Securities Commission (ASC), could not find an “advisor” license within this firm.I found salesperson, dealing representative, mutual fund seller etc., everything but the title they refer to their sales agents as. (there may be a legal exemption involved in here which is damaging the public interest)

TWO, The investments were in an “ADVISOR ACCOUNT”.......which added 2% to the cost of the investments. And the insult was that this was done by a commission salesperson misrepresenting the public into thinking they were an investment “advisor”.

THREE, 100% of the investments were placed into a mutual fund portfolio where the real investment management happens, where investments get picked and chosen. This results in another 2% fee for this to manage the actual mutual funds.

FOUR, is that 100% of the mutuals were the "house brand" rather than independent products. House brand funds are shown to make the firm up to 26 times more money for them, than if they sold you an independent product. (source OSC Fair Dealing Model study) Most sales appear to be going in this direction for exactly that reason. (see IFIC data below)

FIVE, Surprise, the mutual funds held other mutual funds with over 50% of it’s money in once case. This means many fees for phoney "advice" while simply turning the money over to someone else to manage...... adding yet another 2% fee.........

Beyond the above five violations of this elderly person’s account are another half dozen tricks you should be on the lookout for. People who refer to themselves as “advisor’s”, are using the following tricks to make themselves and their company richer, while damaging the interests of their customers.

SIX, AT SOME FIRMS SALES COMMISSIONS are added when buying independent funds. 80% of mutual funds sold in my time were sold using the highest commission choice possible.........despite cheaper alternatives (DSC , deferred sales charge is the sign to knowing you are being "sold" and not "advised")

SEVEN, Then there are those who DO BOTH (double dipping of fees on TOP of commissions) , (and we call those people in the business “vice president’s”:) It goes like this, first sell the customer the name brand fund, get the 5% up front DSC sales commission and THEN a year down the road, convince the customer to move into a fee based account, or into the firms’s house brand account, and add annual fees on top of the first commission based purchase.

EIGHT, Misleading customers into a false sense of security......with fake titles like Vice President, Wealth Management Specialist etc. The thing to be aware of is that the person calling themselves your advisor is doing this while lobbying to remove any customer duties of care owed to you. (the “client interest first” requirement has been removed recently, without notifying the public)

NINE, Then there are the banks who have sloppy product to get rid of, and if they cannot sell them, they are stuck with them. They apply for legal permission to dump them into the accounts of the banks mutual funds, and thus turn the bank's inventory problem into the bank customer’s problem.......never even bothering to tell them......... or simply sell them off to the public, telling unsuspecting clients what great investments they are. Never having to inform them that these investments could not even pass our laws.......$35 billion went that way with ABCP.

“OUR COLLECTIVE IGNORANCE IS HOW THEY GET AWAY WITH CORRUPTION”Join me on facebook please. LARRY ELFORD. And join the Facebook group ALBERTAFraud.com Together we might change the abuse of financial customers by financial professionals. If you have an investment statement that you would like an opinion on, we are happy to take a confidential look. If you have been abused by these tricks, see topic titled GET YOUR MONEY BACK, at this same forum.

By now, you may have realized that you aren't always the most rational manager of your money. Chasing returns. Buying into bubbles. Selling into troughs. Keeping too much in cash or company stock. Heck, even if you keep a textbook, well-diversified portfolio of low-fee index funds, you've still probably felt tempted over the last month or so to buy Apple at $600. (You may turn out to be right in retrospect; that won't make it rational.)

To keep yourself in check, perhaps you've turned to a financial adviser. The majority of retail investors have. If so, a new study posted this month by the National Bureau of Economic Research has some bad news for you: Financial advisers not only fail to curb investors' worst habits, they actually tend to reinforce them -- especially when those habits generate fees for the advisers.

The study, by Harvard economist Sendhil Mullainathan, Markus Noeth of the University of Hamburg and Antoinette Schoar of the MIT Sloan School of Management, looks at the behavior of typical investment advisers available to the general public through their banks, independent brokerages or investment advisory firms (focusing on the market for those with less than $500,000 to invest). These advisers are typically paid on the fees and commissions they generate by selling stocks, mutual funds, insurance products and the like.

To see what kind of advice was doled out by these advisers in real-life situations, the study's authors hired and trained actors to make nearly 300 visits to Boston-area financial advisers over a five-month period in 2008. The actors were assigned to one of four fictional investment portfolios: 1) a returns-chasing portfolio, filled with holdings in sectors that had over-performed in recent years; 2) a portfolio heavily invested in company stock; 3) a diversified, low-fee stock/bond portfolio, and 4) an all-cash portfolio.

So, when the actors came into these offices, what happened? Basically, the advisers advised the dummy clients to do a whole lot of things that were in the advisers' interests, while making some adjustments based on just how much they thought the clients could be persuaded to do.

Most strikingly, the advisers nudged people in low-cost index funds toward high-fee actively managed funds -- blatantly making their clients worse off. Presented with the index-fund portfolio, the advisers recommended a change in strategy more than 85% of the time. Meanwhile, advisers largely encouraged returns-chasers to keep chasing returns. And they tried to nudge cash-only and company-stock investors toward active management, too, though they seemed to take things a bit slower with these clients (apparently inferring that they had a lower tolerance for risk).

While the researchers expected that they might find "catering" behavior -- that is, advisers telling clients to stay on their current course to avoid alienating them -- they largely found that the advisers were willing to recommend big changes fairly quickly (after giving the clients' original strategies a polite reception in their initial reaction).

So, should investors ditch financial advisers entirely? "I wouldn't say that people shouldn't use financial advisers," says Ms. Schoar of MIT. Many people, without an adviser, are too timid to enter the market at all, which isn't good for their financial health. The best advice in the experiment, she said, was given to those who came in without a strategy (that is, those with the cash-only portfolio). While the advice given to these clients wasn't perfect, it was relatively conservative and well-matched to a client's income, age, marital situation and perceived risk tolerance.

The most important thing, she said, was simply to understand how your financial adviser is getting paid. Some charge based on how much capital they're managing, and thus their incentives line up much better with their clients. Some even charge by the hour, which eliminates most conflicts of interest -- though it does leave the client with the vast majority of the work.

In the end, the quality of advice you get from a financial adviser is likely to be tied directly to your financial literacy -- and your willingness to hear advice that doesn't conform to your preconceptions. Individuals who are bad at making financial decisions might also be bad at picking advisers," says Ms. Schoar.

That certainly seems to be the case. A 2008 RAND study of investors' understanding of the roles of investment advisers and stock brokers found that investors have little understanding of how much responsibility either type of service provider has to them (advisers generally have a much greater duty to look out for their clients' interests) or of what types of fees they are paying. Nonetheless, the majority of investors were happy with their financial-service providers.

Just how bad is the gap between the quality of service and people's contentment? Well, despite the abysmal advice offered by the advisers surveyed in the Harvard-MIT study, the actors were willing to go back to 70% of the advisers they visited. This time with their own money.

Investment analyst Dan Hallett and a broker friend debate the pros and cons of deferred sales chargesBy Dan Hallett | March 2012Despite taking the occasional shot at the investment industry, I have a few financial advisor friends remaining. One longtime friend is a very sharp investment advisor at the brokerage arm of a big bank. His firm's compliance department won't let us use his real name, so let's call him Ulysses.Ulysses and I often discuss industry hot-button issues over lunch. We most recently debated the 25-year-old deferred sales charge. Ulysses says the industry should kill the DSC; I'm not a huge DSC proponent but decided to take the pro side. Our discussion:

Ulysses: Back-end loads are something we should say goodbye to for a number of reasons. Just as it usually pays to do the most uncomfortable thing when investing, we must learn to do the same in our own practices. DSCs have long been a notoriously poorly explained approach to advisor compensation and, because of that, advisors recognize that DSCs are — in effect — concealed fees.

Dan: When I started in the industry, I was trained to explain that the client doesn't pay me a cent but that the fund company pays me on his or her behalf. But the DSC mechanism is not inherently evil. The sneakiness disappears with simple disclosures that any compliance officer can embrace.

Ulysses: Yet, so few do explain this. Back-end-load funds have hurt our industry's reputation. Many clients have told me they've dumped their advisors because of lack of communication or poor returns and then expressed shock at the prospect of the mutual fund company clawing back 4% of what they originally invested if transferred to our firm in cash. The trickle of discontent becomes a torrent.

Dan: This has nothing to do with the DSC; rather, it has to do with the failure to document advice properly. We both know that clients don't retain what you tell them for very long. Advice — and details such as DSCs — must be documented in plain English. I agree with regulating disclosure about how DSCs work but not with regulating how investors pay their advisors.

Ulysses: When I started in this business in 1996, I used back-end loads for many clients. It was the way of things then. Fees and trailers were irrelevant, and a back-end load would give you the commission you needed to get paid.I remember having conversations with other advisors about the nature of our business being one of giving advice and getting commissions at the same time. They replied: "That's just the way the advice world works." But I also remember debating that although we espouse patience and putting clients first, we got paid more for activity. What if the right thing to do was nothing? DSCs don't reward advisors for that.And, looking back, back-end loads were much more work — for example, explaining mechanics, allowable switches and inevitably rationalizing clawbacks.

Dan: I'm no DSC cheerleader. But everything you have said has to do with the advisor's professional conduct, not with inherent DSC flaws. Sure, the DSC is easier for ethically challenged advisors to exploit. But there are conflicts with every form of advi-sor remuneration.I started as an advisor in 1994. Although my training wasn't ideal, I was encouraged to read prospectuses and then review the highlights with clients.So, I sold DSC mutual funds but walked every client through the mechanics, rationale, fees and commissions.When I woke them up, they seemingly understood it. And although many didn't retain it all, they went home with documented advice and a marked-up prospectus. I didn't make much money back then.

Ulysses: Dan, I recognize that removing the DSC model is difficult for our industry, and that it will be tougher for newer advi-sors to make ends meet without the 5% up-front DSC commissions. Perhaps new advisors' compensation has to be altered to allow them to build a business.The bank for which I work had put rookies on a special fee grid eight years ago because it was the right thing to do. The bank supported brokers who walked the walk.

Dan: It's much tougher than it used to be. But that's a case for a more professional mentorship model rather than for legislating behaviour.

Ulysses: More education, another course. But will that change behaviour?

Dan: No. But bringing young advisors along more gradually through better mentorship is a better model and can address the industry's succession challenge. But you don't create good advi-sors by tossing rookies into the deep end and holding their heads to see if they can swim.

Ulysses: OK, but you've said before that back-end loads encourage clients to stay invested. I don't buy it. The DSC is not a barrier to investors dumping their investments in a panic when full switching among funds in fund families is allowed.

Dan: In theory, you're right; any investor who had bought a DSC fund a few months ago need not wait six years to make big asset-mix shifts.But my research has revealed two interesting long-term tendencies. The dollar-weighted average holding period for mutual funds reporting to the Investment Funds Institute of Canada has long been six to seven years, which is about the length of the standard DSC schedule. As for capitulation — selling early — mutual fund investors tend to trade less — not more — during down markets. But it will be interesting to see if reduced DSC use will shorten holding periods the way it had lengthened them through the 1990s.

Ulysses: Embedded compensation will be banned in Australia and Britain, according to my peers on LinkedIn. It's time to remove them from Canada. Use the extreme test: either apply the DSC to all fund sales or charge trailer fees only. Which would clients choose?

Dan: Both are embedded commissions, but clients would choose trailer fees. Still, fee-based advisors also have big potential conflicts: they would prefer clients keep money invested rather than spend it on non-investment items. Even fee-for-service planners are incented to maximize the effective fees charged per hour of actual work on client files.But one other positive of DSCs is that they help smaller investors afford financial advice — generous DSC commissions can pay advisors for giving investment advice to smaller accounts.

Ulysses: I'm familiar with that argument. But please note that my employer and its bank-owned competitors offer high-quality advice on a no-load basis. Clients with smaller portfolios are well served by Canada's major banks on financial planning issues.

Dan: That's one of the problems with eliminating DSCs: it effectively gives banks a monopoly on small clients, who, I'd argue, get better advice elsewhere. Plus, if your beef is with conflicted advice, you're suggesting that the only choice most investors should have is to walk into the most captive sales channel in the country.Don't squeeze out independents. Legislate disclosure, let people choose how to pay advi-sors and let market forces decide. It's already happening: DSC sales are half of what they were in the late 1990s.

Ulysses: The trend is, my friend, look at low-load funds … they're like salt-reduced bacon. You know it's a bad thing when you can get a "reduced" version. Low-load funds are just "DSC Light." The implementation of "a little less of a bad thing" only highlights the need to remove the DSC structure once and for all. IE